(Here’s What To Do About It)

TL;DR

Persistent inflation is quietly eroding wealth—even when markets look healthy. Real investment returns are being squeezed, while frozen tax thresholds (“fiscal drag”) mean more of your income and gains are taxed each year. Cash feels safe, but it loses real value quickly. The solution isn’t to take more risk—it’s to be smarter with tax wrappers, diversification, and long-term planning.

Inflation may have come down from last year’s spike, but it’s proving stubborn. We’re no longer in the world of near-zero inflation and ultra-low interest rates that defined the decade after the financial crisis. Instead, the UK looks set for a period of sticky, mid-single-digit inflation—not dramatic, but persistent.

And when inflation becomes persistent, it doesn’t just nudge prices up. It reshapes investment returns, tax planning, spending decisions and long-term financial security.

It’s worth unpacking what that really means for households and investors.

1. Nominal returns can look strong – but real returns tell the truth

A recent example from a balanced portfolio (Vanguard LifeStrategy 60 Equity) illustrates the point:

• 5-year nominal return: +40%
• 5-year inflation (RPI): +28%
• 5-year real return: about 1.8% per year

The headlines look good. The real purchasing-power gain is far more modest.

This is the world we’re planning in now—one where markets can perform reasonably well, and yet inflation quietly eats away much of the progress.

For long-term investors, this puts even more emphasis on thoughtful asset allocation and staying invested. For retirees drawing an income, it highlights the need for a sustainable withdrawal strategy that keeps pace with rising prices.

Planning action:

We focus less on “eye-catching” nominal returns and more on real-return expectations. That means:

• stress-testing client plans against inflation, not just market downturns
• avoiding over-reliance on cash or low-growth assets for long-term goals
• ensuring portfolios remain aligned to the real objective: funding future spending power

2. Cash feels safe, but persistent inflation makes it risky

Cash is a natural refuge in uncertain times. Savings accounts and Money Market funds are paying the best rates in years. But here’s the catch:

• If inflation is 3%
• And your cash is earning 3–4% before tax
• Your real return is close to zero or negative

In other words, £100,000 sitting in cash today could be losing £2,000–£3,000 a year in purchasing power.

Cash protects you from volatility, but not from inflation. For long-term goals, that distinction matters.

Planning action:

We deliberately separate money into:

• short-term cash (for spending and emergencies), and
• long-term capital (structured to grow ahead of inflation)

Holding too much long-term money in cash can be as damaging as taking too much market risk.

3. Fiscal drag is squeezing households—even if tax rates don’t rise

Even if Chancellors avoid big headline tax increases, the government is already raising revenue through a quieter and more effective tool: freezing tax thresholds during an inflationary period.

This is known as fiscal drag, and its impact is significant.

By 2030 (based on OBR inflation assumptions):

• The Personal Allowance will be worth far less in real terms
  → costing a higher-rate taxpayer roughly £592 per year
• The Basic Rate Band also shrinks in real terms
  → costing around £1,184 per year
• The IHT Nil-Rate Band is being eroded too
  → increasing the eventual inheritance tax bill by an estimated £15,000+

All of this happens without any tax rate changes. Inflation simply drags more income into higher brackets, and more estates into IHT.

This is exactly why tax planning is becoming more important than investment selection in many households’ long-term plans.

Planning actions we integrate:

factoring tax drag into long-term projections, not just today’s tax bill

managing income around key thresholds (£50,000, £60,000, £100,000)

using pension contributions, salary sacrifice and Gift Aid to reduce adjusted net income where appropriate

reviewing ownership of investments to ensure both partners’ allowances are fully used

4. What this means for investors and retirees

Here are the practical implications:

a) Long-term investors still need growth assets

With inflation eating away at returns, the role of global equities and real assets becomes even more important. Diversification remains essential—but avoiding growth exposure risks falling behind in real terms.

b) Tax-efficient wrappers matter more than ever

In a world of rising tax burdens, ISAs, pensions and (where appropriate) investment bonds provide shelter from both income and capital gains tax. They’re no longer optional “nice-to-haves” but essential tools for preserving real wealth.

c) Retirement withdrawal plans need revisiting

When inflation was near zero, a 4% withdrawal rule felt comfortable.
With stickier inflation and more tax drag, sustainable withdrawal rates are naturally lower. Periodic review is now critical.

d) Portfolio “safety” needs reframing

The safest portfolio isn’t the one with the lowest volatility.
It’s the one most likely to maintain your standard of living over time.

Planning actions:

We prioritise consistent use of:

• ISAs for tax-free growth and flexibility
• pensions for long-term tax efficiency, income planning and inheritance mitigation
• investment bonds (where suitable) to manage tax timing and rate arbitrage

This isn’t about chasing loopholes — it’s about making sure investment returns are not unnecessarily diluted by tax over time.

5. The bigger picture: staying ahead of inflation and tax

The real message is simple:

You don’t need dramatically higher returns—you need smarter planning to ensure inflation and tax don’t quietly undo years of good decisions.

That means:

• Making full use of ISA and pension allowances
• Managing income levels around key tax thresholds
• Keeping enough growth exposure for long-term goals
• Using wrappers and allowances efficiently
• Reviewing withdrawal strategies regularly

Clients often focus on market volatility.

But over long timeframes, inflation risk and tax drag can do far more damage to wealth than a shaky year in the stock market.

How we mitigate this:

We:

• review withdrawal rates regularly
• build inflation-linked income streams where appropriate
• model retirement income under realistic inflation assumptions, not optimistic ones
• ensure flexibility so withdrawals can adapt during poor market or high-inflation periods

Preventing early erosion of capital is often more important than maximising early retirement income.

Final thought: Planning beats prediction

Persistent inflation doesn’t require dramatic action — but it does demand disciplined, joined-up financial planning. The focus shifts from reacting to headlines to structuring money efficiently, reviewing regularly, and ensuring inflation and tax don’t quietly undo years of hard work.

If your financial plan hasn’t been reviewed through the lens of persistent inflation and fiscal drag, it’s worth revisiting. Small planning decisions made consistently can make a significant difference to long-term outcomes.